Since going public on March 16, 2018, cloud security company
ZScaler (ZS 46.39, +0.34, +0.75%) has issued quarterly reports twice, and on both occasions, it has
delivered impressive upside results highlighted by strong double-digit revenue
and bookings growth. Last week, on September 5, it issued upside 4Q18 results
while also providing upside guidance for FY19. However, the following day, the
stock actually sold-off, closing for trading with a 5% loss.
With ZS up a staggering 175% versus its IPO price, a "sell-the-news" type of reaction was in play as investors and traders looked to lock in those sizable gains. Also, as we discuss below, the stock’s valuation is quite exorbitant.
Today, the stock opened lower after shares rebounded sharply higher on Friday. Before the open this morning, BTIG Research downgraded the stock to Neutral from Buy, likely at least partially due to those valuation concerns.
ZS is the developer of a security cloud platform which is distributed to more than 100 data centers, helping them to accelerate their IT migration to the cloud. This includes the migration of applications from a corporate data center to the cloud, and from a legacy "hub-and-spoke" system (WANs) to an updated direct-to-cloud network. ZS' platform allows traffic to be routed locally and securely to the internet via broadband and cellular connections.
The company's two core services are:
- ZScaler Internet Access (ZIA): This solution securely connects users to externally managed apps, including SaaS applications, and internet destinations, regardless of device, location, or network. It is designed to ensure that malware does not reach the user and that valuable corporate data remains safe.
- ZScaler Private Access (ZPA): This service offers authorized users secure and reliable access to internally managed applications hosted in enterprise data centers or the cloud. The ZPA product connects a specific user to specific applications, without bringing the user on the network. This results in better security and is different from traditional remote access solutions like VPNs.
ZS has over 2,800 customers across all major geographies and its customer base spans every major industry. It implements a joint sales approach in which its sales force develops relationships directly with customers. It bolsters its sales presence by leveraging its network of telecom service providers, system integrators, and re-seller partners.
Q4 Results & Valuation
For the quarter, ZS posed a loss of ($0.01)/share, which exceeded analysts' expectation for a loss of ($0.05)/share and improvemed upon 4Q17's loss per share of ($0.07). In addition to the robust 54% top-line growth, a 2% bump in gross margin to 80% also pushed ZS closer to profitability. The increase in gross margin was driven by an increased mix of higher priced bundles as well as by operational efficiencies.
Revenue of $56.2 mln also topped analysts' $50.7 mln expectation with billings soaring by 73% to $95.4 mln. One of the main catalysts to its growth came from its ZPA product, which is a complementary set of services for internal application access. In the quarter, ZPA surged by 200%, jumping from 4% of revenue to 10%. The product was only introduced two years ago and made available to all sales representatives one year ago. So uptake for ZPA has been rapid, and management is very excited about its potential from an up-sell standpoint.
On that note, its dollar-based revenue retention rate hit 117%, up from 115% a year ago. This strong performance was attributable to selling larger deals up-front as well as success in up-sells. One notable up-sell in Q4 came from a top 10 bank that purchased its Transformation bundle and DLP for 10,000 users six months ago and then added another 55,000 user licenses to cover all of its employees.
Lastly, ZS also made major strides with regards to cash flow. Specifically, cash from operations came in at positive $14.7 mln compared to a cash burn of ($3.7) mln in 4Q17.
There is clearly strong momentum behind ZS' business, and the company has plenty of runway for growth ahead. But with a 1-year forward P/S of 16.5x, much of this positive perspective may already be priced into the stock. Furthermore, the margin for error is quite slim for ZS, so, the company will need to keep outperforming expectations by a decent margin in order to maintain that premium valuation.